Australia holds key rate as governor warns on Trump-induced tremors

[SYDNEY] Australia's central bank left interest rates unchanged, with Governor Philip Lowe instead turning the spotlight abroad to rising US funding costs that could hurt local borrowers.

Mr Lowe and his board kept the cash rate at a record-low 1.5 per cent for a 20th straight month on Tuesday, with markets and economists expecting no change in policy until next year. He signalled increasing concerns at the reverberations from US President Donald Trump's policies amid the US's growing trade spat with China and a recent surge in short-term money market rates at home.

"Equity market volatility has increased from the very low levels of last year, partly because of concerns about the direction of international trade policy in the United States," Mr Lowe said in a statement announcing Tuesday's decision.

US dollar short-term interest rates are "increasing for reasons other than the increase in the federal funds rate". "This has flowed through to higher short-term interest rates in a few other countries, including Australia."

A surge in Treasury bill issuance to fund American budget deficits has been cited as one of the factors sending dollar funding costs higher, both in the US and offshore. Rising borrowing costs Down Under would be uncomfortable for a central bank already concerned about the resilience of households labouring under record-high debt and stagnant wages.

"The RBA (Reserve Bank of Australia) acknowledged higher funding costs and the increased concern around US trade policy but stopped short of much explanation or any forward thoughts," said Su-Lin Ong, Royal Bank of Canada's head of Australian economic and fixed-income strategy.

"Coupled with the additional reference to a steady unemployment rate underpinning considerable slack, and the overall tone of today's statement erred on the dovish side."

The local dollar's reaction to the decision and statement was muted, trading at 77.02 US cents at 4.32pm in Sydney. The currency has fallen more than 5 per cent since it peaked above 81 US cents in late January.

Mr Lowe maintained his view that progress in lowering unemployment and returning inflation to the 2.5 per cent midpoint of its target would be gradual. The lower exchange rate could speed that process up by boosting exports, with a gauge of manufacturing activity rising to its highest level yet in March.

But the picture is muddled. A key reason for the currency's weakness is that iron ore, Australia's biggest overseas earner, slumped into a bear market last month. Australia also risks becoming the meat in the sandwich in any US-China trade war: America is Australia's biggest foreign investor and key security ally, while China is its biggest trading partner.

"We see no justification for a pre-emptive rate hike by the RBA," said Callam Pickering, economist at global job site Indeed, who previously worked at the central bank.

"In fact we consider an early move particularly risky. A potential trade war is the type of development that could really undermine the recent improvement in Australia's economic performance.

Australia's economy is hampered by high debt after households tapped low rates to chase house prices higher in bubble-like conditions in the eastern capitals. Prices have since begun to ease, with Sydney falling 1.7 per cent last quarter and Melbourne 0.5 per cent.

"The bank's central forecast remains for faster growth in 2018," Mr Lowe said, suggesting a more restrained outlook after data last month showed the economy grew a less-than-expected 2.4 per cent in the final three months of 2017.

"One continuing source of uncertainty is the outlook for household consumption, although consumption growth picked up in late 2017. Household income has been growing slowly and debt levels are high."

Unemployment stands at 5.6 per cent, above the 5 per cent estimate of full employment that would normally spur faster wage growth and higher inflation. Inflation, meanwhile, is hovering just below the bottom of the central bank's 2 per cent to 3 per cent target band.

"Inflation is likely to remain low for some time, reflecting low growth in labor costs and strong competition in retailing," Mr Lowe said.

"A gradual pick-up in inflation is, however, expected as the economy strengthens. The central forecast is for CPI inflation to be a bit above 2 per cent in 2018."

BLOOMBERG